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How to influence risk culture through incentives and keep them relevant in a constantly changing world?

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Good conduct is increasingly important in a world of regulations, but how can you make sure that people adhere to it? What about the good old-fashioned carrot-and-stick reward and punishment system? Alicja Nocon, Risk Management Actuary at Munich Re UK, explains why this needs an update and how intrinsic motivators and risk culture can make a difference.

Risk culture can be defined as the behaviours, underlying values and beliefs which influence risk outcomes. Risk culture is an inherent part of effective risk management as it acts as an enabler of policies, procedures and controls within the integrated risk framework.

A strong and embedded risk culture can deliver positive risk outcomes even if the risk framework is deficient in some areas. Conversely a “perfect” risk framework will not appropriately manage risk if there is no buy-in and acceptance into the target business culture. Let us remember the old adage from Peter Drucker, ‘Culture eats strategy for breakfast’. Risk culture is difficult to see and measure directly but can be inferred by analysing an organisation’s risk outcomes and the decisions made by those that lead it. Given that risk culture can be observed, it can therefore be influenced.

Having a good risk culture is critical to the success of a business; a focused business should therefore seek to positively influence its risk culture. The key, of course, is to ensure the business is making strategically balanced risk decisions. Making too risky decisions can, if things go wrong, directly affect the profits and possibly the reputation of the business. Take too little risk and soon you could find yourself way behind your competitors, who have innovated and tried different approaches whilst you remained stagnant.

It is therefore essential to manage the risk culture in order to meet the strategic objectives. But also it is important to consider the risk culture within a wider context of organisational culture, in particular within strategy setting and its translation into workplace policies and performance incentives.

From business strategy and incentives to achieving desired risk behaviours

Communication of business strategy and performance incentives within a business directly impacts staff engagement levels and whether staff are willing to go the extra mile for the benefit of the company and their customers – both being indicators of a good risk culture.

A typical business strategy goes like this: “Our aim is to generate <amount> of profit. We will do this by continuing the existing relationship with client <name> and writing <number> of new transactions. We will act in the best interest of our clients and adhere to all relevant regulations and laws”.

In order to motivate staff to take actions to achieve the strategy, incentives (or disincentives) are put in place by the company and the regulator, for example:

  • Company incentives – financial: e.g. bonuses based on a risk-adjusted performance metric or company shares
  • Regulatory disincentives: e.g. fines for the firm for breach of rules (but also increasingly personal liability for senior managers)

There is a good alignment in this example between good business performance and risk management – use of risk adjusted measures, focus on the long-term horizon and assigning (personal) accountability.

However, both examples intend to influence conduct by focusing on the extrinsic motivation, such as achieving a certain level of wealth and reputation, and using a reward and threat of punishment for wrong-doing (the “carrot and stick”) technique. These approaches are easy to implement but have their limitations.

Financial incentives

“Money is not the only answer, but it makes a difference” – Barack Obama

Financial security is important. It allows people to sustain a desired lifestyle while being able to cover any emergencies and satisfy future goals. Therefore, financial rewards should be a good motivator. And they are, but research shows that there might be a limit to their effectiveness when it comes to personal wellbeing. This is particularly relevant within the millennial generation (born between 1980 and 1999) who seem to value a good work-life balance beyond financial success.

Kahneman and Deaton’s research on whether money buys happiness has shown that beyond the annual household income of c. $75,000 in the contemporary United States, higher income does not improve emotional wellbeing nor alleviate unhappiness or stress (although it does show an improved life satisfaction).

Regulatory fines

A regulatory fine can destroy a long-established reputation and financial viability of a company. The fear of punishment however, does not always work. In particular, when the punishment is inconsequential to the financial success of the business and therefore seen as an acceptable risk.

Take the Facebook Cambridge Analytica fine from 2018. The UK ICO fined Facebook £500,000 which, compared to Facebook’s quarterly net income of $5bn in Q1 2018, makes for less than 20 minutes of a quarterly profit – a drop in the ocean.

The power of the intrinsic motivation in incentivising desired risk behaviours

As shown in the examples above, utilising the extrinsic motivation (e.g. through a financial reward or threat of punishment) is helpful in developing a good risk management culture but may not in itself be enough to foster desired behaviours and risk outcomes.

In my presentation at RiskMinds Insurance 2019, I will explore how tapping into the intrinsic motivation can work alongside the extrinsic motivators in order to further improve risk culture with additional benefits of greater staff health, wellbeing and performance.

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